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Asset Accounting, Fiscal Policy and the UK's Oil And Asset accounting, fiscal policy and the UK’s oil and gas resources, past and future Giles Atkinson and Kirk Hamilton September 2016 Centre for Climate Change Economics and Policy Working Paper No. 280 Grantham Research Institute on Climate Change and the Environment Working Paper No. 250 The Centre for Climate Change Economics and Policy (CCCEP) was established by the University of Leeds and the London School of Economics and Political Science in 2008 to advance public and private action on climate change through innovative, rigorous research. The Centre is funded by the UK Economic and Social Research Council. Its second phase started in 2013 and there are five integrated research themes: 1. Understanding green growth and climate-compatible development 2. Advancing climate finance and investment 3. Evaluating the performance of climate policies 4. Managing climate risks and uncertainties and strengthening climate services 5. Enabling rapid transitions in mitigation and adaptation More information about the Centre for Climate Change Economics and Policy can be found at: http://www.cccep.ac.uk. The Grantham Research Institute on Climate Change and the Environment was established by the London School of Economics and Political Science in 2008 to bring together international expertise on economics, finance, geography, the environment, international development and political economy to create a world- leading centre for policy-relevant research and training. The Institute is funded by the Grantham Foundation for the Protection of the Environment and the Global Green Growth Institute. It has nine research programmes: 1. Adaptation and development 2. Carbon trading and finance 3. Ecosystems, resources and the natural environment 4. Energy, technology and trade 5. Future generations and social justice 6. Growth and the economy 7. International environmental negotiations 8. Modelling and decision making 9. Private sector adaptation, risk and insurance More information about the Grantham Research Institute on Climate Change and the Environment can be found at: http://www.lse.ac.uk/grantham. This working paper is intended to stimulate discussion within the research community and among users of research, and its content may have been submitted for publication in academic journals. It has been reviewed by at least one internal referee before publication. The views expressed in this paper represent those of the author(s) and do not necessarily represent those of the host institutions or funders. Asset Accounting, Fiscal Policy and the UK’s Oil and Gas Resources, Past and Future Giles Atkinson1,2 and Kirk Hamilton2 1 Department of Geography and Environment and 2 Grantham Research Institute on Climate Change and Environment, London School of Economics and Political Science, Houghton Street, London, WC2E 2AE, UK Contact: [email protected] Abstract: The UK has been an exception to the trend of channelling revenues arising from the depletion of subsoil assets into a resource fund. In this paper, we construct an asset account for the UK’s oil and gas resources to evaluate the cost of this exceptionalism and, looking forward, the implications of establishing a fund now. We show that had a decision been made to establish a resource fund in 1975, this fund could now be substantial in size (about GBP 280 billion in 2010). A significant contributor to this result is the historical efficiency of the UK fiscal regime in capturing oil and gas rents, as we demonstrate. A further benefit of the resource fund would have been a reduction in volatility of resource revenues flowing to the Treasury. An ex post cost-benefit analysis of the simulated fund suggests it could have been a sound public investment. However, our simulation of a future resource fund based on (possible) shale gas and oil revenues shows that it could reach a size similar to the 1975-2010 fund only under optimistic assumptions about prices, revenues and economic reserves. Acknowledgements: We would like to thank Renaud Coulomb and Emanuele Campiglio for comments on an earlier draft. 1 1. Introduction The recent evidence that the UK may possess sizable resources of shale gas and oil has prompted reflection about whether the UK ‘wasted’ its North Sea petroleum resource, and whether some form of sovereign wealth fund (SWF) would now be a more effective way to use tax revenues from shale gas and oil exploitation. A meaningful answer to the question of ‘wasted’ assets seems out of reach, not least because of the difficulty of building a plausible counterfactual. But it is worth revisiting the historical data on North Sea petroleum to consider a number of questions concerning the contribution of the sector to the development of the UK economy. Hamilton and Ley (2011) list 12 countries or jurisdictions where resource funds and/or fiscal rules for resource revenues have been implemented.1 Given that North Sea revenues reached 9.9% of fiscal revenues and 3.7% of GDP in 1984, with revenues exceeding 1% of GDP from 1979 to 1987, it is fair to ask whether the UK was an outlier in not establishing some form of SWF (for a historical analysis of the UK oil and gas industry see, e.g. Kemp, 2011a,b; Harvie, 1994; Stewart, 2013). Exhaustible resources and the revenues they generate present two broad problems for macroeconomic management: gross production and tax revenues tend to be large and highly volatile, and the stream of revenues is finite, ending when the resource deposit ceases to be economic. Large flows of resource tax revenues lead to the distinct risk that fiscal policy will be pro-cyclical and hence a source of macroeconomic instability. And the finite nature of the resource revenue stream raises important questions about the sustainability of the macroeconomy – will wellbeing fall as the resource is exhausted? The contribution of this paper is to demonstrate how asset accounting can throw light on this debate in a number of ways. We construct natural resource asset accounts for the UK covering the period 1975 to 2010 in order to examine several key aspects of the North Sea experience (for a general discussion see UN, 2013; Hamilton and Hartwick, 2014, Obst and Vardon, 2014). Building resource asset accounts requires the estimation of resource rents, and these rents provide a useful benchmark for the effectiveness of revenue capture from petroleum production through the tax regime (henceforth, in this paper, ‘resource revenues’). This is because the rent is, in effect, the payment owed to the owner of the natural resource, e.g. the government (for a broader discussion of resource taxation, see Keen and MacPherson, 2010). The resource asset accounts also yield a measure of the value of resource depletion (Hamilton, 2014), another useful benchmark for resource revenue generation. Finally, we integrate the resource asset account with national accounts data to calculate a fundamental sustainability indicator, ‘adjusted’ net savings, and related indicators of net wealth creation. As Ossowski et al. (2008) argue, some combination of a natural resource fund and fiscal rules on the use of resource revenues can reduce pro-cyclical tendencies and provide investments and savings to support future wellbeing in extractive economies. Recent interest has focused in particular on how resource revenues could be channelled into a financial asset such as a 1 Some of these funds combine saving and stability objectives (e.g. Kuwait and Norway) while other countries have funds for one objective only (e.g. savings in Alaska and Alberta and stability in Papua New Guinea and Venezuela) or separate funds to serve distinct objectives (e.g. Oman). 1 sovereign wealth fund (SWF) (see also, for example: Davis et al. 2003; van der Ploeg, 2014, Hassler et al. 2015; Clark et al. 2013).2 We simulate a simplified version of the Norwegian Government Pension Fund for the UK by assuming that all resource revenues from the North Sea were invested in a global portfolio of financial assets, and that the fund paid out a fixed percentage of assets, 3.9%, to the Treasury from 1975 to 2010.3 The simulation answers four questions. First, how large a sacrifice, in terms of reduced current revenues, would this have entailed? Secondly, in what year would fund payouts have exceeded current resource revenues? Thirdly, how much would the fund have reduced the volatility of resource revenues flowing into the Treasury? Finally, how large would the fund and the payout have been in 2010? Looking forward, we also simulate a SWF for the UK that begins operation in 2015. The fund accumulates revenues from the declining North Sea reserves and, starting as early as 2025, accumulates (potential) revenues from shale gas and oil as well. Under the most favourable projections for recoverable resources, extraction, prices and rents, by 2040 this fund could grow as large as the fund we simulate for 1975 to 2010. Yet for less favourable projections, this potential fund is smaller, possibly significantly so and underlining further perhaps past opportunities missed. Our conclusions on the effectiveness of resource taxation in the UK are positive: on average 65% of resource rent and 80% of resource depletion values were captured by taxes and royalties over 1975-2010. The conclusions on the sustainability of the economy are less encouraging – if we deduct the value of resource depletion from published estimates of net national saving for the UK, in most years this measure is less than 4% of GNI and it approaches 0 in some years. The simulated SWF for 1975 to 2010 shows that sacrifices in terms of foregone current revenues to the Treasury would have been large, 10-20 billion constant 2010 GBP, over the years 1979 to 1987. By 1988, however, payouts from the SWF would have exceeded resource revenues and the value of the fund would have doubled the size of the government balance sheet by 2010.
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